Professional relationships compromised
A conflict of interest arises when you or your brokerage office, acting on behalf of a client, have a competing professional or personal bias which may hinder your ability to fulfill the fiduciary duties you have undertaken on behalf of your client.
In a professional relationship, your financial objective of compensation for services rendered is not a conflict of interest. It is an exchange of known quantities; your services and their payment. However, whether you represent a buyer or seller, they are entitled to know the exact amount of compensation you will receive arising out of any aspect of the employment relationship.
Thus, fees and benefits derived from other sources need to be disclosed to the client. These include compensation in the form of:
- professional courtesies such as referrals;
- familial favors; and
- preferential treatment by others toward you or your agents. [See RPI Form 119]
Similarly, the referral of a client to a financially controlled business owned or co-owned by you or others in your brokerage office is a financial benefit from a transaction disclosed by use of an affiliated business arrangement (ABA) disclosure. [See RPI Form 519 and 205]
In contrast to brokerage fees, a conflict of interest addresses your personal relationships potentially at odds with the agency duty of care and protection owed the client.
Thus, a conflict of interest creates a fundamental agency dilemma — it is not a compensation or business referral income issue.
Unless disclosed and you have the client’s consent, the conflict is a breach of your fiduciary duty of good faith, fair dealing and trust owed to the client when you continue to act on the client’s behalf.
When a conflict of interest arises and becomes evident to you, whether patent or potential, you need to disclose it as soon as possible after the conflict arises. Typically, the conflict arises when you provide property information to a prospective buyer or take a listing from a seller.
Disclosures of personal or client conflicts create transparency in the transaction. You reveal to the client the bias you hold which, when disclosed, allows the client to take the bias into consideration in negotiations. The disclosure and consent does not neutralize the inherent bias itself. However, it does eliminate the element of deceit which breaches your fiduciary duty when left undisclosed.
Potential overlaps of allegiance or prejudice with persons other than your client which are a conflict you need to disclose to your client include:
- you or others in your brokerage office hold a direct or indirect ownership interest in the real estate, including a partial ownership interest in a limited liability company (LLC) or other entity which owns or is buying, leasing or lending on the property;
- an individual related to you or someone in your brokerage office by blood or marriage holds a direct or indirect ownership interest in the property or is the buyer;
- an individual with whom you or a family member has a special pre-existing relationship, such as prior employment, significant past or present business dealings, or deep-rooted social ties, holds a direct or indirect ownership, leasehold, or security interest in the property or is the buyer;
- concurrent representation by you or others in your office of the opposing party, a dual agency situation; or
- an unwillingness by you to work with the opposing party, or others, or their brokers or agents in a transaction.
Simply, a conflict of interest arises and is disclosed to the client when you have a pre-existing relationship with another person that might hinder your ability to fully represent the needs of your client, due to:
- common club membership;
- religious affiliation;
- civic ties; or
- any other socio-economic context.
Legislatively, comprehensive rules do not exist setting forth instances where a conflict of interest arises and needs to be disclosed.
Thus, brokers are left to draw their own conclusions when situations regarding a property or a transaction with or involving third-parties arise. In practice, brokers, and especially agents, all too often err on the side of nondisclosure, putting their broker fee, if not their license itself, at risk. [Calif. Business and Professions Code §10177(o)]
Generally, when you even question whether it is appropriate to disclose a potential conflict of interest to a client, the conflict needs to be disclosed. The existence of any concern is reason enough for a prudent agent to be prompt in seeking their client’s consent to the potential conflict. By timely disclosing a conflict of interest and obtaining consent, you immediately reinforce your honestly-held working relationship with your client.
Fundamentally, an agent who becomes aware they have a conflict of interest, but is reluctant to disclose it and seek the client’s consent, needs to consider rejecting or terminating their employment with that individual.
When employed as a seller’s agent, you need to disclose your acquisition in a sale of any direct or indirect interest in the seller’s property. You also need to disclose whether a family member, a business owned by you, or any other person holding a special relationship with you will acquire an interest in the seller’s property. [See RPI Form 527 §3.6]
Consider an agent whose brother-in-law makes an offer to buy a property the agent listed. The purchase agreement states the broker represents the seller exclusively and is to receive a fee for their services.
The agent does not disclose to the seller that the buyer is their brother-in-law.
The agent opens two escrows to handle the transaction. The first escrow facilitates the sale and transfers the property from the seller to the agent’s brother-in-law.
The second escrow is for the sole purpose of transferring title to the property from the brother-in-law to an LLC in which the agent holds an ownership interest. Both escrows close and the agent receives their fee (via their broker).
The seller discovers the buyer was their agent’s brother-in-law and the true buyer was an entity partially owned by their agent. The seller demands a return of the broker fee claiming the agent had a conflict of interest which breached the fiduciary duty owed the seller — it was not disclosed and the seller did not consent.
Here, the agent and broker are not entitled to retain the broker fee they received from the seller. Further, the seller is entitled to recover any property value at the time of the sale in excess of the price they received. Alternatively, the seller may set the sale aside due to the failure of the broker’s agency with the seller and the conflict of interest which undermined the agent’s fiduciary duty owed the seller.
An agent cannot act for more than one party in a transaction, including themselves, without disclosing their dual agency and obtaining the client’s consent at the time the conflict arises. [Bus & P C §10176(d); see RPI Form 527]
Also, a seller’s agent has an affirmative duty to disclose to the seller their agency or other conflicting relationship they have with the buyer. The duty to disclose exists without the seller ever inquiring into whether the agent has a relationship with the buyer. It may be assumed the agent does not have conflicts — none were disclosed.
Further, failure to disclose a broker’s personal interest as a buyer in a transaction when they are also acting as a broker on behalf of the seller constitutes grounds for discipline by the Real Estate Commissioner. [Whitehead v. Gordon (1970) 2 CA3d 659]
When acting as a buyer’s broker, you need to disclose to the buyer the nature and extent of any direct or indirect interest you or others in your brokerage office hold in any property presented to the buyer when the buyer expresses an interest by inquiring further about the property.
Consider an agent employed by a buyer who shows their buyer several properties, one of which is co-owned by the broker, vested in the name of an LLC. The buyer seeks additional information on the property vested in the LLC. A marketing package is handed to the buyer, but the agent does not inform the buyer of the broker’s indirect ownership interest in the property.
The buyer decides to acquire the property owned by the LLC. An offer is prepared on a purchase agreement with an agency confirmation provision stating the broker is the agent for both the buyer and seller. The offer is submitted to the LLC. [See RPI Form 159]
The agent, aware the buyer will pay a higher price for the property than the initial price offered by the buyer, presents the buyer with a counteroffer from the LLC at a higher selling price. The buyer accepts the counteroffer.
Here, the seller’s agent and their broker have a duty to promptly disclose their ownership interest in the property to the buyer the moment the conflict arises — the inquiry for additional property information beyond the promotional flyer. The conflict of interest in the broker’s ownership is a material fact requiring disclosure since the buyer’s decisions concerning acquisition of the property might be affected.
As a result of the nondisclosure, the buyer can recover the fee received by the broker and the increase in price under the counteroffer.
Had the buyer known the broker held an ownership interest in the property when it was first presented, the buyer may have negotiated differently when setting the price and terms for payment. Alternatively, the buyer may have retained a different broker who was not compromised by a conflict of interest.
When you act solely as a principal in the sale of your own property, you are not restricted in your conduct by compliance with agency obligations other than dealing honestly in disclosures about the property and in response to inquiries from the buyer. Thus, a broker selling or buying property for their own account acts solely as the seller or buyer. Your licensee status is not a conflict due to its existence since you are not holding yourself out as a broker or agent acting on behalf of another person in the transaction. [Robinson v. Murphy (1979) 96 CA3d 763]
In contrast, when you receive a broker fee on the sale or purchase of your own property, you hold yourself out as a transaction agent and subject yourself to real estate agency requirements. In addition, you incur taxes at ordinary income rates on the amount labeled a fee.
Consider a broker who sells their residence. The residence is in violation of safety requirements for occupancy due to known defects in the foundation. The broker does not tell the buyer about the foundation defects (a dishonest activity).
Out of the proceeds received on closing the sale of the property, the broker-seller pays themselves a broker fee, noting they exclusively represent themselves in the purchase agreement agency confirmation provision (which is not an agency and does not require a license).
The buyer later discovers the residence needs to be demolished and rebuilt with an adequate foundation. The buyer obtains a money judgment against the broker for breach of their general agency duty owed to all parties in a real estate transaction to disclose known property defects.
The broker is unable to pay the money judgment. The buyer makes a demand for payment on the Real Estate Recovery Account.
Recovery is received from the Real Estate Recovery Account since the broker held themselves out as acting as a real estate broker in the transaction by receiving a fee. The broker’s license is suspended due to the payment. Before the broker can reactivate their license, they need to reimburse the Recovery Account. [Prichard v. Reitz (1986) 178 CA3d 465]
Also, conduct alone is enough to create an agency relationship with your buyer. When you hold yourself out by your conduct as representing the buyer as their agent, you need to fulfill the duties arising out of the agency relationship with the buyer. Otherwise, your license may be revoked the California Bureau of Real Estate (CalBRE). [Buckley v. Savage (1960) 184 CA2d 18]
The client’s tardy discovery of the conflict and their complaint to the CalBRE for failure to make the disclosure and obtain consent before continuing to advise or act on behalf of the client are grounds for the suspension or revocation of the broker’s license by the CalBRE. [Bus & P C §10177(o)]